The dilemmas the GCC's economies must grapple with in 2014

As is typical in the profession, economists are pessimistic about the future, but it is wise to heed their advice, lest their warnings are borne out by the facts

The International Monetary Fund (IMF) recently published its annual assessment of GCC economies and their outlook in 2014. It makes clear how fast GCC economies have been growing since the global financial crisis. However, it points out to the challenges they face in the near and medium run, if appropriate precautions are not taken now to face those challenges.First the good news: Since 2009, GCC combined GDP, or the total value of goods and services provided, has grown by over 68 percent during the past four years, from $955 billion in 2009 to an estimated $1.6 trillion in 2013. Current account balance, which has been enviably positive for a long time, has grown even faster during those four years, from $108 to $361 billion in 2013 (estimate), an overall increase of 235 percent.That rapid growth has been fueled mainly by rising oil revenue due to a sharp rise in oil prices,[2] from $62 per barrel in 2009, to around $105 per barrel in 2013 (measured as a simple average of Brent, WTI and Dubai Fateh prices), an increase of about 69 percent (almost exactly equal to GDP growth). In addition, there was a smaller increase (19 percent) in oil production during that period, from 14.5 to 17.2 million barrels a day.Because of the volatility inherent in oil prices, the IMF expects downside pressures during 2014, as well as longer-term structural challenges. For short term, in 2014, the IMF expects downside pressures ranging from around 7 percent, due to expected re-intensification of the crisis in the euro area, to 20 percent, if combined with a prolonged slowdown in emerging market. Those effects could be magnified if oil production in the United States also increases more rapidly than expected.It is true of course that most GCC countries have accumulated large official external assets and would be able to comfortably weather temporary declines in oil income. Total public external assets in the GCC are estimated at nearly $2 trillion, which could be used to make up for any shortfall in oil revenue.However, GCC countries differ in the size of their asset cushion and consequently the ability to cover that shortfall also varies. Increasing oil production to make up for the decline in oil prices may not be an option for all, due to OPEC commitments and the need to maintain a healthy ratio between oil production and oil reserves, especially for countries with low or declining reserves. If the short-term downside pressures continue, that could lead to gradual depletion of foreign assets, combined with reductions in private-sector confidence and foreign investment inflows, which would affect the non-oil sector, as well as the government sector.You see the dilemma that the IMF is hinting at. If policymakers continue their expansionary policies to make up for declining oil income, they could draw down their foreign assets and reduce investors’ confidence. If on the other hand they go pro-cyclical and reduce spending, they reduce consumers’ confidence, and their citizens’ welfare, with ill effects on the economy either way.Now for the next dilemma: Increasing revenues have led to higher expectations for higher public sector salaries and greater entitlement programs. It would be very difficult to reduce those kinds of expenditures if oil revenue declines. As a result, more demands would be placed on public assets, both internal and external. In addition, boosting public-sector employment and wages,[3] as publicly demanded and expected, could work counter to the objectives of current policies to increase the share of nationals in the private sector.This leads us to the biggest challenge for GCC economies: Providing gainful and productive employment for their growing populations. So far, most GCC nationals work in the public sector. However, government employment may not accommodate all nationals, especially in countries with large native populations such as Saudi Arabia. As a result, they experience double-digit unemployment for nationals because, in part, the prevailing wages in the private sector are too low to attract nationals. The private sector has become habitually dependent on the unlimited supply of cheap expatriate labor.The result is a dilemma rarely experienced in economic history of any region: Low productivity and low responsiveness of the employment of nationals to economic growth. Paradoxically, in the GCC rapid economic growth is not accompanied with low unemployment rates, but the opposite: Increasingly high rates of unemployment. While there are energetic reforms under way in all GCC countries to increase the employment of nationals in the private sector, they may take some time to show results. In addition to prevailing low wages in the private sector, that delay may be due to well-entrenched cultural norms, slow changes in educational quality, widening gap between public and private sector employment conditions, but especially due to prevailing laissez-faire labor market policies.Similarly, native small and medium enterprises have benefited less from the rapid growth in GCC economies. GCC countries generally rank high in overall competitiveness and “Doing Business” indicators,[4] which explains in part their rapid economic growth and increasing investment inflows. However, SMEs have not benefited equally from that growth. In part, that is due to limited financing available from banks, which prefer historically to lend to larger enterprises where they can limit their risk exposure. As SMEs tend to be the largest sources of job creation, their health could contribute to solving the unemployment problem, as well as the growth of the non-oil sector.As is typical in the profession, economists are pessimistic about the future, but it is wise to heed their advice, lest their warnings are borne out by the facts. Key to dealing with challenges of the future is the development of a high-skilled, well-educated native labor force[5], and a healthy SME sector that could employ those workers and contribute to economic growth if oil revenue hits a snag.